Stock Awards and 409A

[Scott]

Perhaps this is out there somewhere, but I have not seen a clear answer to the question of how a stock award that is subject to 409A must be drafted to comply with 409A. Here's the situation: Company A has granted nonqualified stock options (nondiscounted and no deferral feature) and restricted stock to employees of Company B. The relationship between Company A and Company B does not satisfy the requirements under the proposed regs for Company A to constitute the "service recipient." Thus, the awards are subject to 409A and there is no "fix" (as there is for discounted options) to exempt them.

How must the options be amended to comply with 409A? Since the regs provide that a calendar year can be designated as the payment date, can the options provide that they can be exercised at any time during a specified calendar year? Must anything else be done to them?

For the restricted stock, is it really subject to 409A, and if so, what exactly does that mean? The shares will vest according to a vesting schedule, at which time the shares will be unrestricted and the employee will be taxed. It seems that the payment date and the vesting date are the same, which should satisfy the short-term deferral exemption. Am I missing something?

[Guest cac1134]

at first thought, where is the compensation? where is the deferral? why do you think this is subject to 409A. a nondiscounted grant that will be recognized at exercise seems outside the scope.

[Scott]

Proposed regulation section 1.409A-1(b)(5)(i)© states that "an option to purchase stock other than service recipient stock . . . generally will provide for the deferral of compensation . . . ." Unless I'm totally off-base, a deferral of compensation that isn't earned and vested as of 12/31/04 (which most of these are not) is subject to 409A.

[Guest cac1134]

scott: i have to agree with your interp of the reg cited. what is this? a start-up or venture capital thing? is the exemption for independent contractors helpful for you?

[Scott]

The issuer of the stock awards is a corporation which is the general partner of a limited partnership. The stock awards are granted to employees of the partnership. The relationship between the corporation and the partnership creates an affiliated service group under 414(m), but the 409A regs address only 414(b) and ©.

[Guest jcrawford]

Are you sure your partnership and the corporation are not a controlled group under 414©, probably under the voting control test?